An incurrence covenant is a loan provision that prohibits certain future actions — additional debt, dividends, asset sales — unless the borrower satisfies predefined financial conditions at the time of the action.

How it works

Debt documents include affirmative and negative covenants. Incurrence-style restrictions say: you may incur new debt only if pro forma leverage stays below a set ratio, or you may pay dividends only if cash coverage exceeds a threshold. The test runs when the action occurs, not continuously every quarter. This contrasts with maintenance covenants, which require ongoing compliance regardless of plans. Venture debt and growth-stage loans often blend both types. A company planning an acquisition needs to model whether the deal triggers incurrence tests on existing credit facilities. Breaching an incurrence covenant blocks the transaction or constitutes default if completed without waiver.

Why it matters

• Founders: Before signing venture debt or term loans, map future fundraising and M&A plans against incurrence baskets and ratio tests.
• Investors: Covenant packages affect portfolio company flexibility during downturns when waivers may be costly or unavailable.

Common mistake

Ignoring covenants because the company passes today. Growth plans that add debt or reduce EBITDA can suddenly block strategic moves.

Related ideas

Maintenance covenant, interest coverage, venture debt, and leverage ratio tests work together in credit agreements.